Posted by Brian Fechtel on June 26, 2013
This week we have a guest post from Brian Fechtel, CFA, founder of BreadwinnersInsurance.com. He was one of the contributing authors to the NAIC’s White Paper on the State of Life Insurance Industry, having written a section advocating the importance of drastically improved policy disclosures. Last September the Journal of Financial Planning published his article, “Bringing Real Clarity and Understanding of Cash-Value Life Insurance to the Marketplace.” The comments below very briefly summarize for fi360’s fiduciaries some of the practical implications of Fechtel’s ideas.
>>>>>It is an axiom that to make good decisions, one needs good information. Unfortunately, when it comes to the life insurance industry’s products, information that is good and appropriate can be difficult to find. Moreover, the extent of the problem is not widely nor well understood.
Consider the following: many think that cash value policies can be compared by their sales or in-force illustrations. But policy illustrations are not financial projections. More than 20 years ago, actuaries declared that illustrations ought not to be used to compare policies. And, contrary to many advisers’ and clients’ presumptions, illustrations are not even required to be financially sustainable. An illustration, quite simply, is nothing but a hypothetical future scenario. Would any fiduciary that you know make a decision entirely on a hypothetical scenario, or comparisons of such, without understanding the real financials underlying the scenario? To make good decisions, one needs genuine, appropriate information.
Moreover, without appropriate information, basic misconceptions persist, if not flourish, and with real, harmful consequences. For instance, some think that that there are two types of life insurance, term and permanent; and that term is akin to renting and permanent akin to owning. But this conceptualization contains the very seeds of poor decisions and costly mistakes. After all, all life insurance is comprised of term insurance. To assert that a term policy is the least costly form of life insurance is both to overlook this basic fact and to fail to consider the after-tax costs of different policies. Similarly, the presumption that a permanent policy bought long ago probably provides good value today because it allegedly locked-in a cost based on a much younger age is pure financial poppycock. Misconceptions regarding annuities and long-term care insurance have also been especially disastrous. In fact, until LTCI is understood as a contingent deferred annuity (and a repriceable, yet non-transferable and non-participating, policy), shopping for such coverage can be akin to looking for fine jewelry in a toy store.
The solution, of course, is to understand the life insurance industry’s products the same way one understands any financial product: by obtaining good, appropriate information from an expert who can explain such. For instance, the value a policyholder receives from a cash-value policy depends ultimately upon the financial performance of the insurer. This fact is true even of guaranteed, no lapse policies, given that a guarantee is only as good as the guarantor. Consequently, the following five questions are natural starting points for any fiduciary seeking excellent value for a client contemplating, for example, a cash value policy:
What is your insurer’s rate of return earned on its relevant investments, and credited on its policies?
How cost-effective and productive are your life insurer’s home office and agent operations?
Of the insurer’s pool of insureds’ coverage, a) what share was underwritten the past five years and b) remains on the books even ten years after being issued?
How competitive are your insurer’s average mortality costs, and what are the implications of uncompetitive costs for you?
How fairly does your insurer distribute its earnings?
Given that financial decision-making may actually begin with risk management, and that good decisions cannot be made without appropriate information, there ought to no longer be any question about the need for fiduciaries to obtain excellent information about the life insurance industry’s products. Unfortunately, so much of the information that is awash in this marketplace is anything but excellent. It is, however, now hoped that the recent clarion calls for excellent information, and the ongoing demonstrations of its real efficacy, will enable you to better serve your clients going forward.